Don’t Fall Off The IRS Cliff
With a Self-Directed IRA, there is a lot more responsibility placed on the IRA account holder.
As a “Self-Directed Investor,” you have to be proactive and willing to pay attention to what’s going on with your investments. If you don’t have the desire or the time to spend on managing your account, then a Self Directed IRA might not be for you.
There are many pitfalls to watch out for when making your investments. Here are three that I think are very important:
1. PROHIBITED TRANSACTIONS
Through a self directed IRA, you can invest in just about anything you want, other than non-allowable assets, such as life insurance and collectibles.
Also, according to the rules and guidelines, the only catch is that you may NOT make any investments with disqualified parties.
Who are disqualified parties?
By definition, a disqualified party includes you, your spouse and any lineal descendants, more specifically family members (Mom, Dad, Grandma, Grandpa, your kids, & their spouses, etc.).
This is by no means a complete definition. If you ever have a question about whether or not someone would be considered a disqualified party, be sure to consult with a CPA or tax attorney.
To see the IRS definition, visit http://www.irs.gov/irm/part7/irm_07-027-020.html.
Now that you know who disqualified parties are let’s talk about some other types of prohibitive transactions.
We now know an investment with a disqualified party or purchasing life insurance or collectibles is considered to be a prohibitive IRA transaction, but what else? A prohibited transaction may occur anytime you try to use your IRA to benefit you personally or vice versa. For instance, if you use your IRA to purchase an investment beach house in Miami, you cannot stay in it for a week (or any amount of time for that matter). Even if you are paying your IRA a fair rental rate for the time that you are there, it would still be considered a prohibited transaction.
Another question I get a lot goes like this, “I’ve got this great little piece of land that I own personally, can I sell or assign it to my IRA?” The answer is “NO!!!”
Selling land you already own to your IRA would be considered a prohibited IRA transaction. We already know that YOU are considered a disqualified party to your own IRA, so that eliminates selling it to your IRA because you cannot purchase anything from a disqualified party. Second, all contributions to an IRA must be made in cash. A piece of land is obviously not cash, so this eliminates the possibility of assigning anything to your IRA.
2. Do Your Own Vetting And Due Diligence Prior To Making an Investment
This one is extremely important and I can’t stress it enough. As we all know, there are tons of dishonest people in the world. More and more often we pick up the newspaper to see people like Bernie Madoff, who have swindled people out of millions through their Ponzi schemes.
The last thing besides an IRA prohibited transaction, you would ever want to have happen to your retirement account is to fall prey to a 3rd party investment scam artist.
My advice to you is to do your research. Look into the company. Ask tons of questions. Don’t make any rash decisions. If a company is pressuring you to make a quick decision or offering you incentives and bonuses to get your money to them more quickly, these should be “red flags” that something is suspicious. Remember, there’s no such thing as a free lunch. If something sounds too good to be true, it probably is.
While self-directed IRAs can be a safe way to invest retirement funds, investors should be mindful of potential fraudulent schemes when considering a self-directed IRA. Investors should understand that the custodians and trustees of self-directed IRAs may have limited duties to investors, and that the custodians and trustees for these accounts will generally not evaluate the quality or legitimacy of an investment and its promoters. www.Nsaa.org.
3. Unrelated Business Income Tax “UBIT” – This is a BIGGIE
What is UBIT? Unrelated Business Income Tax or UBIT applies to certain types of investments through your IRA. It’s basically put in place to keep IRA investments from having unfair advantages over regular, tax-paying businesses. Your IRA may be subject to Unrelated Business Income Tax if it is involved in any of the following:
- Operates a trade or business,
- Receives certain types of rental income,
- Receives certain types of passive income from a business entity it controls,
- Invests in a pass-through entity, such as a partnership, that conducts a business, or
- Uses debt to finance investments.
If you have any questions about UBIT or whether or not an IRA investment that you are involved with will be subject to UBIT, we strongly urge you to consult a CPA or tax attorney.